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In an opinion released September 9, 2022, the Online Merchants Guild (“Guild”) secured a victory against the Pennsylvania Department of Revenue (“Department”) in its attempt to collect information and back taxes on an estimated 11,000 out-of-state sellers who stored inventory in Amazon’s warehouses in Pennsylvania. See Online Merchants Guild v. Hassell, Pa. Commw. Ct. No. 179 MD 2021, 9/9/2022.

During 2012, Amazon and the Pennsylvania Department of Revenue (“Department”) entered into an agreement whereby Amazon agreed to voluntarily collect and remit Pennsylvania sales tax on its internet sales.  However, that agreement did not extend to third-party Fulfilled by Amazon (“FBA”) sales.  As the name suggests, FBA sales are fulfilled entirely by Amazon.  FBA sellers ship their inventory to a warehouse designated by Amazon; they cannot select the warehouse.  Amazon then collects payment from the customer and ships the merchandise directly from its warehouse.

During 2017, the Department developed a strategy for collecting sales tax from FBA sellers that had a physical presence in Pennsylvania by virtue of their inventory being stored in Amazon’s warehouses within the state.  During 2018, Amazon entered into a second agreement with the Department whereby it agreed to collect and remit sales tax on FBA sales.  FBA sellers remained liable for any pre-2018 FBA sales and for any FBA sales where Amazon failed to collect.

Members of the Guild began receiving Business Activities Questionnaire Requests (“Questionnaire”) from the Department indicated that they “may have” a physical presence in Pennsylvania that would require the collection and remittance of Pennsylvania sales tax and the payment of personal income tax (“PIT”).  The Questionnaire noted that, pursuant to the Tax Code, storing property (including inventory) at a distribution or fulfillment center or any other location within Pennsylvania constituted physical presence that created sales and income tax obligations in the state.  Finally, the Questionnaire noted that the failure to provide the requested information would result in “additional enforcement actions.”

During 2021, the Guild filed a petition for review with the Commonwealth Court and ultimately both parties filed cross-applications for summary relief.  The primary issue before the court was whether the FBA sellers were subject to the sales tax and PIT provisions of the Tax Code because Amazon stored their merchandise in warehouses located in the Commonwealth.  Additionally, the Guild argued that the Department lacked the authority to collect sales tax in a retroactive manner, that the relevant provisions of the Tax Code do not apply to the Guild’s nonresident members, and that Revenue’s enforcement efforts violate the federal Internet Tax Freedom Act (ITFA).

The Due Process Clause of the U.S. Constitution protects citizens from unfair tax burdens by limiting the power of states and their political subdivisions to impose extra-territorial taxation. To comply with the Due Process Clause, such taxation is restricted to cases in which there exists “some definitive link, some minimal connection, between the state and the person, property[,] or transaction it seeks to tax[.]”  The existence of minimum contacts requires “some act” by which an entity “purposefully avails itself of the privilege of conducting activities within the forum [s]tate, thus invoking the benefits and protections of its laws.” Wirth, 95 A.3d at 838 (quoting Hanson v. Denckla, 357 U.S. 235, 253 (1958)).

In its opinion, the Commonwealth Court explained:

The placement of goods into the stream of commerce with an expectation that they will be purchased by a state’s consumers may indicate purposeful availment; however, “as a general rule, it is not enough that the defendant might have predicted that its goods will reach the forum [s]tate.” As we noted in Equitable Life, “[t]he simple but controlling question is whether the taxing authority has given anything for which it [could] ask [in] return.”

Moreover, the court stated that the Due Process Clause requires a connection between the taxing authority and the person or entity it seeks to tax and “some act” indicating the alleged taxpayer has availed itself of the taxing authority’s protections, opportunities, and services.  Given the facts of the FBA sellers’ relationship with Amazon and their lack of knowledge of, or involvement in, where their inventory was stored, the court proclaimed: “[w]e are hard pressed to envision how, in these circumstances, an FBA Merchant has placed its merchandise in the stream of commerce with the expectation that it would be purchased by a customer located in the Commonwealth, or has availed itself of the Commonwealth’s protections, opportunities, and services.”

The court also questioned the “circuitous line of reasoning” the Department presented in justifying its ability to seek information from suspected taxpayers, reasoning:

…if we correctly follow Revenue’s reasoning, FBA Merchants, simply by virtue of having enrolled in the FBA Program, have placed themselves within Revenue’s jurisdiction and thus have no means to challenge Revenue’s authority to investigate their records and determine their tax liability until after Revenue has investigated their records and determined their tax liability…Critically, Revenue’s investigative powers under Section 272 apply to the records of taxpayers, not individuals or entities Revenue suspects may be taxpayers.  Furthermore, Section 272 does not grant Revenue the unfettered authority to seek business information from any person or entity it desires for the purpose of determining its status as a taxpayer.

Accordingly, the court granted the Guild’s cross-application for summary relief and denied the cross-application for summary relief filed by the Department.

The case includes an important review of the Due Process Clause, as well as the limits upon a taxing authority’s ability to target and impose burdens upon out-of-state taxpayers.  Out-of-state taxpayers should consider how this decision may impact any alleged tax liabilities in Pennsylvania.  Moreover, taxpayers that receive a Questionnaire from the Department should consider how this opinion affects them prior to responding. 

Jennifer Karpchuk is co-chair of the State and Local Tax (SALT) Controversy and Planning practice at Chamberlain Hrdlicka. She can be reached at jennifer.karpchuk@chamberlainlaw.com.